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Business

In the accounting world, resisting sunlight

NEW YORK — The accounting business has sometimes had an attitude of — how shall I put it? — contempt for those who would regulate it. The people who run the major firms know best, and regulators should yield to their superior judgment.

Nowhere is that clearer than when regulators penalize partners of big firms. The Tammy Wynette song “Stand by Your Man” could be the industry’s anthem.

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In 2001, when the Securities and Exchange Commission settled charges against Arthur Andersen for its involvement in financial fraud at Waste Management, a partner named Robert G. Kutsenda was banned for a year. He was not the partner in charge of the Waste Management audit, but an e-mail showed he had approved accounting that the SEC said was improper.

While that settlement was being negotiated, Andersen put Kutsenda in charge of revising the firm’s “document retention” policy. The new policy encouraged the destruction of the kind of documents that became evidence against him. His involvement became public later in 2001, when Andersen’s auditors cited that policy as justifying their destruction of documents related to audits at Enron. Regulators were not amused.

That case led to the demise of Andersen and, in 2002, to passage of the Sarbanes-Oxley Act, which established the Public Company Accounting Oversight Board to regulate the auditing industry.

Now, something similar has happened.

The oversight board this week announced it had censured Deloitte & Touche and fined the firm $2 million. It seems that in 2008, the board suspended Christopher E. Anderson, a Deloitte partner, after concluding that he had approved accounting that allowed truck manufacturer Navistar to cook its books while he was the partner in charge of the company’s audit. He was barred from being “an associated person” of any accounting firm for one year.

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Anderson stepped down as a partner at Deloitte, but he did not leave. He went to work as an employee at the firm’s national office. Among the areas in which he was deemed an expert were “Fair Value/Use of Specialists and Fraud,” according to a Deloitte directory.

There is evidence that Deloitte needed such expertise. In 2008, a board inspection of Deloitte concluded that it had failed to properly audit the use of specialists in several cases involving the fair value of assets. In a confidential part of the report, the board said its inspections indicated that “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.”

At the time, Deloitte responded to the board by saying it did not like the “second-guessing” shown by the regulators. It said “we strongly take exception” to the observation about its culture, which it said was simply wrong.

Years later, in 2011, the board released the confidential part of that report, saying Deloitte had failed to put in place the required changes during the year after the report was written.

So now we know that during the year the firm did not make the required changes, it used an auditor who had been banned from the industry as an expert in the very areas in which the board had found it deficient.

What does that say about Deloitte’s culture? Five years later, he remains with Deloitte.

In 2011, Deloitte’s then-new chief executive, Joe Echevarria, sounded apologetic when I talked to him about the board’s rebuke. This week he was unavailable for comment about the board’s censure. The firm issued a statement saying that in 2008 it had taken “several significant actions to restrict the deployment” of Anderson, who was not supposed to work on client audits, but did.

The firm said it had instituted reforms to “prevent a similar matter from arising in the future,” adding “Deloitte takes very seriously all orders and actions of the PCAOB.” A spokesman added that “our engagement with the PCAOB has been extremely constructive over the past few years.”

This comes out as the board is considering whether to force US accounting firms to tell investors the name of the partner in charge of an audit. In the past, the industry has bitterly fought such a provision, and the board has never taken a final vote on it.

In a comment letter last year, Deloitte wrote, “We are not aware of evidence showing that disclosing an engagement partner’s name in the audit report would increase the partner’s sense of accountability or that it would cause the engagement partner to exercise greater care.”

Now there is such evidence. In a paper in the September-October issue of the Accounting Review, two accounting professors, Joseph V. Carcello of the University of Tennessee and Chan Li of the University of Pittsburgh, looked at what happened in Britain after that country began requiring audit partners to be identified in 2009. They examined audits of the same company in the year before the disclosure and the first year of the disclosure.

They found that after the partners knew their names were going to be disclosed, auditors were more likely to issue qualified opinions and less likely to sign off on audits with managed earnings. The numbers reported by companies after the change tended to provide better indications of future cash flows than had been the case.

Such identification of auditors has been going on for many years in Sweden, where nearly all companies, private and public, are required to disclose their audits. That enabled three academics to study audits of different companies done by the same partners of the Swedish affiliates of the Big Four firms.

Of interest is their finding that investors notice. Companies with more lenient auditors have to pay more to borrow money, and public companies with such auditors trade at lower valuations than do companies whose auditors have earned better reputations.

If you audit a firm and fail to uncover a major fraud, perhaps you should expect your reputation to be harmed.

The Public Company Accounting Oversight Board is expected to unveil its latest proposal in December.

“Professionals routinely disclose their identity, and they do so proudly,” James R. Doty, chairman of the oversight board, said. “Why are auditors different?”

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